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International tax: Towards a new direct tax code

The pre-election union Budget was expected to be on populist lines and the current Budget lived up to this trend. The Budget focussed on social outlay and tax reform was not the main driver.

     Print Edition: Budget 2008 Special

 
Srinivasa Rao, Partner & India International Tax Leader, Ernst & Young
“While the corporate sector may have hoped for more from the current Budget, the social schemes of the UPA government will have long-term benefits for the Indian economy”

Srinivasa Rao
The pre-election union Budget was expected to be on populist lines and the current Budget lived up to this trend. The Budget focussed on social outlay and tax reform was not the main driver.

While a recessionary threat exists over the global economic landscape, the Indian economy itself has stayed strong and buoyant over the last year. In these relatively prosperous circumstances, and given that this Budget is the government’s final full-year Budget before the next elections, some trace of populism was almost inevitable.

On the direct tax side, given the buoyancy in revenues, there were expectations that the education cess and surcharge embedded in the effective income-tax rate would be partially or cumulatively removed. The Finance Minister did not oblige and quite unexpectedly, the tax rate on shortterm capital gains has been increased to 15 per cent from the existing rate of 10 per cent. The proposal to offer credit to underlying dividend distribution tax in a two-tier parent/ subsidiary corporate structure is a welcome move, though the fine print does not seem to have been worded as benevolently as the concept itself.

However, several pre-Budget recommendations did not find a place in the Budget. The depreciating dollar against the rupee has been a matter of concern. A number of players in the software industry had proposed extension of the tax holiday benefits. There were also proposals to introduce the mechanism of Advance Pricing Arrangements given the aggressive approach adopted by the Indian tax authorities in the ongoing audits and for those concluded for the last year. This would have provided certainty around the pricing of cross-border, intercompany transactions. Another issue that multinationals have been grappling with relates to permanent establishment (PE) and income attribution. In a few of the recent cases, the tax tribunals have adopted an ad hoc approach to determine the level of income attributable to multinationals where there has been a PE determined.

It would have been in the interest of all if there was a separate deciding authority with international tax expertise to decide on such matters.

 Experts speak

The use of companies incorporated in favourable tax jurisdictions to mitigate India capital gains tax, popular with MNC investors, has been a contentious matter in India. There has been speculation that the government may consider introducing anti-abuse provisions in the domestic tax law to mitigate Tax Treaty abuse and to override earlier court decisions on the subject.

The Budget did not contain any clarifications on the taxation of such transactions. The Finance Minister also did not comment on the much-publicised direct tax code, which is expected to be circulated later this year. It is possible that some of these proposals will find a place in the new code.

The UPA government over the last few years has been able to balance development and build a platform for inclusive growth. To conclude, while the corporate sector may have hoped for more from the current Budget, the social schemes of the UPA government will have long-term benefits for the Indian economy provided these are efficiently implemented.

Srinivasa Rao is Partner & India International Tax Leader, Ernst & Young

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